CAC Drops on Soft French CPI, Hawkish Federal Reserve

The CAC index has lost ground on Thursday, continuing the downward trend seen on Wednesday. The index has dropped 1.21% and is currently trading at 5187.80 points. On the release front, French Final CPI dipped to 0.0%, shy of the estimate of 0.1%. This marked a 4-month low. As well, the eurozone trade surplus fell sharply, coming in at EUR 19.6 billion. This was well short of the forecast of EUR 22.4 billion. On Friday, we’ll get another look at inflation, as the eurozone releases Final CPI. The markets are braced for the inflation indicator to drop to 1.4 percent.

France will wrap up parliamentary elections on Sunday, when voters determine the makeup of the 577-seat National Assembly. French President Emmanuel Macron is expected to win a huge majority, with some polls giving Macron’s En Marche party a staggering 80% of the vote. A strong majority in parliament will facilitate Macron’s pro-business agenda, such as overhauling France’s labor laws and making the economy more competitive. Macron is a strong supporter of the European Union, and a Macron-Merkel alliance could strengthen the EU at a time when Brexit and nationalistic parties on the continent have undermined European unity. Macron, who is expected to support a hard line against Brexit, said that the EU would leave the “door open” in case Britain changed its mind and decided to stay in the club, but that is clearly a far-fetched scenario.

US consumer data was soft in May, as CPI and retail sales reports missed the forecasts. CPI declined 0.1%, short of the estimate of 0.2%. Inflation has now declined twice in three months, and the current level of 1.5% is well below the Federal Reserve’s target of 2.0%. Retail Sales, the primary gauge of consumer spending, was dismal, coming in at -0.3%, compared to a forecast of +0.1%. This marked the indicator’s weakest reading since August 2016. If consumer spending remains weak, it could drag down GDP for the second quarter, as consumer spending accounts for more than two-thirds of economic growth. Although surveys continue to show that US consumers remain optimistic about the economy, this hasn’t translated into stronger consumer spending.

As expected, the Federal Reserve raised rates on Thursday by 25 basis points, to a target range of 1.00 percent to 1.25 percent. The rate statement portrayed an optimistic picture, noting that the economy was growing, and the labor market remained strong. As for inflation, which remains stubbornly low, the statement acknowledged that inflation remained below the Fed’s target of 2.0%, but expected that goal to be reached in the “medium term”. The Fed projected one more rate hike in 2017, and the markets are circling the December meeting as the most likely date. The odds for a September increase are at 18%, compared to 23% a week ago, according to the CME Group. As for a December increase, the odds are currently at 38%. One surprising development was that Fed Chair Janet Yellen outlined a plan to reduce its $4.2 trillion balance sheet (comprised of Treasury bonds and mortgage-backed securities). Yellen was short on specifics, saying that the goal was to begin the normalization “relatively soon”. The balance sheet ballooned after the financial crisis in 2008, as the Fed implemented a massive quantitative easing program as part of its accommodative monetary policy, together with interest rates of zero. The gradual reduction in the purchase of these assets signifies an important vote of confidence in the strength of the US economy.

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Kenny Fisher joined OANDA in 2012 as a Currency Analyst. Kenny writes a daily column about current economic and political developments affecting the major currency pairs, with a focus on fundamental analysis. Kenny began his career in forex at Bendix Foreign Exchange in Toronto, where he worked as a Corporate Account Manager for over seven years.

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